If a hedging relationship no longer meets the criteria to qualify for the simplified hedge accounting approach, the hedging relationship must be prospectively discontinued from the date the criteria were no longer met. A private company can also elect to discontinue a simplified hedge accounting relationship.
On the date the simplified hedge accounting approach is discontinued, a private company must calculate the fair value of the swap (not the settlement value) and record the difference between settlement value and fair value in other comprehensive income. Subsequent changes in the fair value of the swap will be reported in earnings unless the private company meets the requirements for cash flow hedge accounting using a method other than the simplified hedge accounting approach; in that case, the private company may designate a new hedging relationship prospectively.
Treatment of the gains and losses previously deferred in accumulated other comprehensive income upon discontinuance of a simplified hedge accounting relationship will depend on the cause of discontinuance and the original hedge documentation.
• If the forecasted hedged interest payments are still probable of occurring, amounts in accumulated other comprehensive income should be released when the interest payments are recorded in earnings.
• If the forecasted interest payments are considered probable of not occurring, amounts in accumulated other comprehensive income are reclassified to earnings in the current period.
Example DH 11-2 and Example DH 11-3 illustrate this distinction.
EXAMPLE DH 11-2
Hedged forecasted interest payments are probable of not occurring
On January 1, 20X1, Private Co enters into a $5 million, 10-year loan with an interest rate of 3-month LIBOR plus 2.50%.
Private Co concurrently enters into an at-market 10-year receive 3-month LIBOR, pay-fixed interest rate swap with a notional amount of $5 million to economically convert the loan’s variable rate interest payments to a fixed rate.
All of the requirements to qualify for the simplified hedge accounting approach are met. Private Co designates the interest rate swap as a cash flow hedge of the variable-rate interest payments and elects to apply the simplified hedge accounting approach. In its hedge documentation it defines the hedged transactions as the forecasted LIBOR interest payments associated with the specific January 20X1 loan.
Five years later, Private Co repays the loan. The hedging relationship no longer qualifies for hedge accounting because the hedged interest payments will no longer occur.
Should Private Co recognize the gains and losses on the swap accumulated in other comprehensive income in earnings immediately?
Analysis
Yes. The gains and losses on the swap accumulated in other comprehensive income should be reclassified to earnings immediately because the hedged forecasted transactions (i.e., the interest payments on the January 20X1 loan) are probable of not occurring.
EXAMPLE DH 11-3
Hedged forecasted interest payments are probable of occurring
On January 1, 20X1, Private Co enters into a $5 million, 10-year loan with an interest rate of 3-month LIBOR plus 2.50%.
Private Co concurrently enters into an at-market 10-year receive 3-month LIBOR, pay-fixed interest rate swap with a notional amount of $5 million to economically convert the loan’s variable rate interest payments to a fixed rate.
All of the requirements to qualify for the simplified hedge accounting approach are met. Private Co designates the interest rate swap as a cash flow hedge of the variable-rate interest payments and elects to apply the simplified hedge accounting approach. In its hedge documentation it defines the hedged transactions as the first forecasted LIBOR-based interest payments to occur each quarter on $5 million of borrowings over the next 10 years (i.e., the hedging relationship is not tied to a specific borrowing).
Five years later, Private Co refinances its debt with a new lender. The new loan has interest payments based on 1-month LIBOR. The hedging relationship no longer qualifies for the simplified hedge accounting approach because the variable interest rate on the loan (1-month LIBOR) does not match the variable interest rate on the swap (3-month LIBOR) so Private Co dedesignated the hedging relationship and discontinues hedge accounting.
Should Private Co recognize the gains and losses on the swap accumulated in other comprehensive income in earnings immediately?
Analysis
No. The gains and losses on the swap accumulated in other comprehensive income should continue to be deferred because the forecasted transactions (as defined) are still probable of occurring since Private Co will continue to incur interest payments indexed to LIBOR on $5 million of borrowings for the term of the hedge. The gains and losses on the interest rate swap deferred in accumulated other comprehensive income would not be reclassified until the forecasted interest payments are recorded in earnings.